Investors looking to increase hedge fund exposure

The vast majority (79 percent) of investors plan to maintain or increase their exposure to hedge funds in the next 12 months, according to the 2019 Preqin Global Hedge Funds Report.

Despite a turbulent 2018, which culminated in negative returns at the end of the year, assets under management in the hedge fund industry are forecast to increase over the coming year and beyond as investors continue to look to the asset class for downside protection.

The report notes: ‘Amid uncertainty in equity markets, hedge funds continue to offer investors diversification and uncorrelated returns for their respective portfolios.’

‘These funds provide value by diversifying portfolios, managing risk and helping deliver reliable returns over time,’ writes Richard Baker, president and CEO of the Managed Funds Association, in the report.

The report notes that the market shocks and drops of 2018 will be at the forefront of investors’ minds as they make portfolio decisions in 2019. ‘Investors are largely unimpressed with how their hedge fund portfolios fared in 2018, with only 45 percent saying their hedge fund portfolios met or exceeded expectations, down from 72 percent in the previous year,’ it observes.

‘Failed expectations have, in previous years, driven many institutions to reduce their exposure to hedge funds. But it is the capital protection a hedged portfolio can offer, and not necessarily the absolute performance of their portfolios, that will influence investors’ 2019 plans.’

Historically, the report states, institutional investors have sought year-on-year returns of 6 percent to 9 percent at a lower volatility than the traditional beta-driven portfolio. ‘Despite the negative portrayal of hedge funds in the headlines, investors do not expect their hedge fund portfolios to perform spectacularly,’ the report states. ‘Instead, investors look for hedge funds to generate a consistent Sharpe ratio (measure of risk-adjusted return) that complements their portfolio in all market conditions.’

Following a period of consistently positive returns that began in late 2016, hedge funds’ Sharpe ratio reached 1.49 in January 2018 – its highest level since November 2015 – a figure trumped again in September 2018 when it reached 1.62.  

‘The evidence of a consistent Sharpe ratio highlights the potential for hedge funds to produce risk-adjusted returns, which could explain why the proportion of surveyed investors looking to maintain or increase allocations over the next 12 months is at its highest point since November 2014,’ observes the report.

With investors intending to position more defensively in 2019, those funds with a large long exposure to equity markets may see significant outflows, as investors look to strategies that are less correlated to market beta such as macro strategies, futures contract CTAs and market-neutral strategies, notes the report.

‘With general sentiment suggesting we are heading toward a market correction – if we’re not already in the middle of one – the hedge fund environment will begin to look quite different,’ the report continues. ‘Investors will seek to rebalance their portfolios in an attempt to shift themselves toward more defensive strategies, and it is clear that despite a disappointing 2018 in terms of performance, they will (by and large) continue to allocate to the asset class in order to seek downside protection through the coming turbulence.’

Whether or not hedge funds can deliver this will be crucial for investors during 2019.